Knock-off K-Cup competition has arrived, but in relatively modest volumes. We expect volumes to ramp, but don’t think there is massive supply hitting the market in the near-term.

There is ample gross profit available to support price competition in the single-serve category, however, capacity constraints on knock-off portion packs and strong demand have resulted in modest, not severe, price competition to date.

K-Cup sell-through in the grocery and mass channel has been healthy. Coupled with low K-Cup inventories, solid retail sell-through raises the likelihood of healthy wholesale shipments.

Overhead absorption has been a big pressure on gross margins in recent quarters, but we believe the combination of strong retail sell-through, right-sized K-Cup inventories, reduced capital expenditures, and new branded partners make it likely that overhead absorption pressures on gross margins will ease in 2013.

We also expect lower coffee costs to aid margins. We estimate the 2011-2012 spike in coffee prices drove coffee to over 50% of K-Cup cost of sales. Coffee costs have flipped positive and will ease further in 2013.

The price in GMCR shares reflects Street concerns that GMCR morphs into a modest growth business at dramatically lower gross margin rates without a corresponding tightening of operating expenses over the next couple of years – we find it difficult to envision that all three of these developments occur and believe evidence of these trends will be sparse in the near to mid-term.

2013E EPS goes from $2.33 to $2.55 and revenues from $4.33 billion to $4.60 billion

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